Labor market search, sticky prices, and interest rate policies

What accounts for the significant real effects of monetary policy shocks? And what accounts for the persistent and hump shaped responses of output and inflation in response to such shocks? These questions are investigated in a model that incorporates labor market search, habit persistence, sticky prices, and policy inertia. While habit persistence and price stickiness are important for the hump shaped output response and the long, drawn out inflation response, respectively, labor market frictions increase the output response and reduce the inflation response relative to an otherwise similar model based on a Walrasian labor market. Significantly, policy inertia itself is found to be the most important factor in accounting for the magnitude of the output effects of policy shocks in the model.     

Price stickiness, trend inflation, and output dynamics: a cross‐country analysis

Abstract.  Sticky price models based on menu costs predict that countries with high trend inflation should have (i) smaller impact effects of demand shocks on output and (ii) less persistent output fluctuations, relative to low‐trend inflation countries. These predictions are tested, controlling for changes in trend inflation, using a country‐specific approach. The results do not support the second prediction. That prediction is also not robust to a modified measure of trend inflation that excludes episodes of hyperinflation. These findings suggest that while price stickiness is important for understanding short‐run impact effects, real propagation mechanisms may drive persistence in output fluctuations.     

Optimal Monetary Policy

Optimal monetary policy maximizes the welfare of a representative agent, given frictions in the economic environment. Constructing a model with two sets of frictions—costly price adjustment by imperfectly competitive firms and costly exchange of wealth for goods—we find optimal monetary policy is governed by two familiar principles. First, the average level of the nominal interest rate should be sufficiently low, as suggested by Milton Friedman, that there should be deflation on average. Yet, the Keynesian frictions imply that the optimal nominal interest rate is positive. Second, as various shocks occur to the real and monetary sectors, the price level should be largely stabilized, as suggested by Irving Fisher, albeit around a deflationary trend path. Since expected inflation is roughly constant through time, the nominal interest rate must therefore vary with the Fisherian determinants of the real interest rate. Although the monetary authority has substantial leverage over real activity in our model economy, it chooses real allocations that closely resemble those which would occur if prices were flexible. In our benchmark model, there is some tendency for the monetary authority to smooth nominal and real interest rates.     

MONEY,CAPITAL, AND EXCHANGE RATE FLUCTUATIONS*

We explore how the informational frictions underlying monetary exchange affect international exchange rate dynamics. Our perfectly flexible price model is capable of producing endogenously rigid international relative prices in response to technology and monetary shocks. The model is capable of accounting for the empirical regularities that the real and nominal exchange rates are more volatile than U.S. output, and that the two are positively and perfectly correlated. The model is also consistent with other standard real business cycle facts for the United States.     

The equity price channel in a New-Keynesian DSGE model with financial frictions and banking

This paper studies the role of the equity price channel in business cycle fluctuations, and highlights the equity price channel as a different aspect to general equilibrium models with financial frictions and, as a result, emphasizes the systemic influence of financial markets on the real economy. We develop a canonical dynamic general equilibrium model with a tractable role for the equity market in banking, entrepreneur and household economic activities. The model is estimated with Bayesian techniques using U.S. data over the sample period 1982Q01–2015Q01. We show that a dynamic general equilibrium model with an equity price channel well mimics the U.S. business cycle. The model reproduces the strong procyclicality of the equity price. The equity price channel significantly exacerbates business cycle fluctuations through both financial accelerator and bank capital channels. Our results support the increasing emphasis on common equity capital in Basel III regulations. This is beneficial in terms of financial stability, but amplifies and propagates shocks to the real economy.     

Inflation and Price Adjustment: An Analysis of Microdata

I use large datasets on prices by products and stores from recent inflationary periods in Israel to compare simple menu cost models with simple uncertain and sequential trade (UST) models. The main empirical findings are (a) price erosion due to inflation explains only a tiny fraction of the variation in nonzero nominal price changes, (b) stores whose last nominal price change was relatively low are likely to choose a nominal price change that is relatively high, (c) stores that reduce their nominal price charge a lower price relative to stores that increase their nominal price, and (d) relative price variability is not related to inflation. Journal of Economic Literature Classification Numbers: E300, E310, D210.     

Labor market institutions and aggregate fluctuations in a search and matching model

This paper explores the influence of labor market institutions on aggregate fluctuations. It uses a dynamic, stochastic, general equilibrium model characterized by search and matching frictions in the labor market and nominal rigidities in the goods market. It finds that firing costs and unemployment benefits can have substantial effects on aggregate fluctuations. Increasing firing costs decreases the volatility of output, employment, and job flows due to the reduction in the mass of jobs sensitive to disturbances and lower incentives for firms to hire and fire workers. Hence, firms adjust to shocks mainly through prices, causing inflation to become more volatile. Raising unemployment benefits has the reverse effect on aggregate fluctuations.     

State-dependent pricing, inflation, and welfare in search economies

We investigate the welfare effects of inflation in economies with search frictions and menu costs. We first analyze an economy where there is no transaction demand for money balances: Money is a mere unit of account. We determine a condition under which strictly positive inflation is desirable. We relate this condition to a standard efficiency condition for search economies. Second, we consider a related economy in which there is a transaction role for money. In the absence of menu costs, the Friedman rule is optimal. In the presence of menu costs, the optimal inflation rate is negative for our numerical examples provided menu costs are small. A deviation from the Friedman rule can be optimal depending on the extent of the search externalities.     

Output,inflation, and interest rates in an estimated optimizing model of monetary policy

This paper examines the impact of sticky price and limited participation frictions, both separately and combined, in a dynamic stochastic general equilibrium model. Using U.S. data on output, inflation, interest rates, money growth, consumption, and investment, likelihood ratio tests and Bayesian pseudo-odds measures reveal that the data prefers a model with both structural features. Our results also show that the combined model mimics many important features of the business cycle. In particular, the model generates plausible impulse responses, and monetary policy shocks are responsible for only a modest amount of output, inflation, and nominal interest rate movements.     

Endogenous monetary policy and the liquidity effect

We compare the transmission mechanism of exogenous and endogenous monetary policies in a calibrated small open economy model with nominal and real rigidities. Under an exogenous monetary policy rule it takes implausible values of the intertemporal elasticity of substitution and the price adjustment costs to generate the liquidity and overshooting effects. Endogenous rules with strong feedback to inflation and output help to reproduce the response of the nominal interest and exchange rates to unanticipated monetary policy shocks that characterize the transmission mechanism of standard sticky price models. The liquidty and overshooting effects are always obtained when the model is augmented with a Taylor interest rate rule.JEL Classification: E32, E43Javier Andrés acknowledges support of CICYT grant SEC2002-0026. We thank the comments of two anonymous referees and the editor, Jordi Caballé, to an earlier version of the paper. The views expressed here are those of the authors and do not represent the view of the Banco de España.     

Policy trade-off in the long run: A new Keynesian model with technological change and money growth

In this study, we introduce a constant rate of technological change and money growth into the standard new Keynesian model, in which both prices and nominal wages are supposed to be sticky. Using such a model, we examine whether a policy trade-off exists between curbing inflation and stabilizing the welfare-relevant output gap in the steady state. If we take only price stickiness into consideration, a policy trade-off does not occur. However, if both nominal wage stickiness and price stickiness are taken into consideration, a policy trade-off occurs.     

Firm-specific capital, nominal rigidities, and the Taylor principle

In the presence of firm-specific capital the Taylor principle can generate multiple equilibria. Sveen and Weinke [New perspectives on capital, sticky prices, and the Taylor principle, J. Econ. Theory 123 (2005) 21-39] obtain that result in the context of a Calvo-style sticky price model. One potential criticism is that the price stickiness which is needed for our theoretical result to be relevant from a practical point of view is somewhat to the high part of available empirical estimates. In the present paper we show that if nominal wages are not fully flexible (which is an uncontroversial empirical fact) then the Taylor principle fails already for some minor degree of price stickiness. We use our model to explain the consequences of both nominal rigidities for the desirability of alternative interest rate rules.     

INFLATION AND THE DISPERSION OF REAL WAGES*

The article studies the effects of inflation on real wage dispersion in a search‐monetary framework. The economy is characterized by frictions in both the goods and the labor markets. In the goods market, buyers and sellers bargain over prices, whereas in the labor market firms post wage offers. In equilibrium, a lower inflation rate increases the dispersion of real wages. This result is consistent with both the observed trends in wage dispersion and the inflation rate witnessed in the 1980s and the 1990s in the United States and the empirical literature linking reduced inflation to greater wage dispersion.     

Do sticky prices increase real exchange rate volatility at the sector level?

We introduce the real exchange rate volatility curve as a useful device to understand the relationship between price stickiness and the fluctuations in Law of One Price deviations. In the presence of both nominal and real shocks, the theory predicts that the real exchange rate volatility curve is a U-shaped function of the degree of price stickiness. Using sector-level US–European real exchange rate data and frequency of price changes, we estimate the volatility curve and find the predominance of real effects over nominal effects. Good-by-good variance decompositions show that the relative contribution of nominal shocks is smaller at the sector level than what previous studies have found at the aggregate level, consistent with significant averaging out of good-specific real microeconomic shocks.     

声誉、搜寻成本与网上交易市场均衡

本文在搜寻理论的框架内分析了在卖家声誉存在差异的情况下,网上拍卖市场搜寻成本对价格水平和价格离差的影响,进而考察了搜寻成本对网上市场声誉机制的影响。本文的结论是:尽管搜索工具提高了网上交易市场的效率,但网上交易市场仍存在不可忽视的搜寻成本;较高的搜寻成本导致不同声誉水平的卖家同时存在于网上交易市场,高声誉卖家制定的价格较高,低声誉卖家制定的价格较低;搜寻效率的提高可以降低均衡价格水平,网站提供的推广服务也可以降低搜寻成本,降低均衡价格水平。模型很好地解释了网上拍卖市场中的一些现象,也与最近文献的经验事实有较好的吻合。     

Optimal fiscal and monetary policy with sticky wages and sticky prices

We determine the optimal degree of price inflation volatility when nominal wages are sticky and the government uses state-contingent inflation to finance government spending. We address this question in a well-understood Ramsey model of fiscal and monetary policy, in which the benevolent planner has access to labor income taxes, nominally risk-free debt, and money creation. Our main result is that sticky wages alone make price stability optimal in the face of shocks to the government budget, to a degree quantitatively similar as sticky prices alone. Key for our results is an equilibrium restriction between nominal price inflation and nominal wage inflation that holds trivially in a Ramsey model featuring only sticky prices. Our results thus show that when nominal wages are sticky, setting real wages as close as possible to their efficient path is a more important goal of optimal monetary policy than is financing innovations in the government budget via state-contingent inflation. A second important result is that the nominal interest rate can be used to indirectly tax the rents of monopolistic labor suppliers. Taken together, our results uncover features of Ramsey fiscal and monetary policy in the presence of a type of labor market imperfection that is widely-believed to be important.     

The Optimality of a Zero Inflation Rate with Menu Costs: Australia

This paper juxtaposes the policy trend towards a zero inflation rate against the theoretical standard of optimal deflation at the real interest rate. It extends an example monetary economy to include a simple form of nominal adjustment costs and calibrates the model with recent evidence on Australian money demand. There is a critical value that the calibrated parameter for menu costs must exceed in order for a zero inflation rate to be optimal. An inflation rate of –2 per cent to 0 per cent is found to be optimal. The quantitative results, of whether inflation-adjustment costs imply a zero inflation rate policy for Australia, are tempered by the abstraction of the model and its sensitivity to parameters. Qualitatively, the paper shows the effects of changes in the adjustment cost function and in the structural parameters.     

Tax,credit constraints,and the big costs of small inflation

This paper develops a heterogeneous‐agent overlapping generations model that examines how the neutrality of the tax system with respect to inflation depends on the price elasticity of the housing supply. The model, which endogenises house prices and rents, and which incorporates detailed tax regulations and bank‐imposed credit constraints, shows (a) inflation has large effects on the tenure arrangements of young households irrespective of the housing supply elasticity; and (b) inflation can improve the welfare of some low income young households if the supply is sufficiently elastic. The welfare costs of inflation are reduced by taxing real rather than nominal interest.     

Inflationary expectations and monetary policy: evidence from Bangladesh

This article first estimates inflationary expectations using a Blanchard–Quah VAR model by decomposing the nominal interest rate into expected inflation and the ex ante real interest rate. Then I utilize this expected inflation along with other macroeconomic variables as inputs to the monetary policy function in a recursive VAR model to identify exogenous policy shocks. To calculate inflationary expectations, I assume that ex ante real interest rate shocks do not have a long-run effect on the nominal interest rate. This article finds that the public expects lower inflation for the future during periods of high inflation. Estimated results from the recursive VAR suggest that a contractionary policy shock increases the real interest rate, appreciates domestic currency, and lowers inflationary expectations and industrial output. However, I find a lagged policy response from Bangladesh Bank to higher inflationary expectations.     

Price-level targeting rules and financial shocks: The case of Canada

How important are the benefits of low price-level uncertainty in the presence of financial shocks? This paper explores the desirability of price-level path targeting in a small open economy with credit frictions à la Bernanke et al. (1999). The model features credit flows and exogenous shocks that originated in both domestic and international credit markets. Financial shocks, exacerbating the distortion generated by the debt-deflation channel, provide a rational for an interest-rate response to the price-level. Indeed, a price-level targeting rule reduces the trade-off between the nominal debt distortion and the inefficiency generated by nominal price stickiness. The policy implications are based on social welfare evaluations. Parameter's uncertainty does not significantly affect the main results.